Global economic fate hinges on European finance talks

WASHINGTON — The fate of the global economy, European unity — and the 401(k) savings of ordinary Americans — all hang in the balance as Europe's leaders meet over the weekend to try to resolve a burgeoning debt crisis that threatens to spread globally.

The leaders are expected to decide at their European Union summit by next Wednesday whether and how to expand the controversial bailout fund they created earlier this year. They also must decide how to add extra cash to their faltering banks — in need of somewhere between $100 billion and $300 billion — in order to prevent collapses or runs by nervous depositors.

And they must decide whether Greece, the region's basket case that sparked the crisis, gets more rescue support and how much.

That's a pretty full plate. So full that leaders of France and Germany, the preeminent powers of the 27-member European Union, will continue meeting into next week rather than finishing their EU summit as planned on Sunday.

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Technically, EU leaders have pledged to reach some resolution before leaders of the 20 most advanced economies — the G-20 — meet in Cannes, France, on Nov. 3-4. But investors across the globe are increasingly restless, and if EU leaders don't make visible progress soon, financial markets across the globe could spiral down as soon as Monday.

There's much more at stake in Europe than just the debt woes of a few countries. Six decades of work to integrate European economies, which collectively include 500 million consumers and economic activity in excess of $17 trillion — more than the USA, could unravel if leaders fail to find a solution.

"You've got a short-term problem, which is Greece ... and a longer-term problem where there are some serious structural and design flaws in the European Union," said Nariman Behravesh, chief economist for forecaster IHS Global Insight.

For more than a decade, Europe has had a common currency, the euro, and monetary policy set by a single entity, the European Central Bank. But the 27 member nations each have retained sovereign responsibility for taxation and spending, and many have amassed huge debts. It's as if the United States did not having a national Treasury Department and instead all 50 states had their own.

"It doesn't work. A unified currency without a political union, without a fiscal union — a federal system — just isn't going to fly," said Behravesh.

But adopting a common fiscal system would require countries with millennia of history to cede their sovereignty to some higher EU bureaucracy. Proud citizens of each nation likely would object, which means the politics of democratic Europe may preclude the EU from taking the structural economic reforms it needs to survive.

"We all know what to do, but we don't know how to get re-elected once we have done it," Jean-Claude Juncker, Luxembourg's prime minister, recently acknowledged.

Yet if Europeans fail to build a new economic order, an EU collapse would have severe economic consequences everywhere.

The 2008 U.S. financial crisis drove home how interconnected the global financial markets have become. When U.S. investment bank Lehman Brothers went bankrupt, a wave of panic swept global financial markets and credit froze across the planet.

Much like Americans angry about bank bailouts, Europeans aren't happy about having to bail out indebted nations such as Greece or Portugal. Most experts now think a structured default by Greece on its government bonds is inevitable.

There've been numerous debt defaults in the developing world in recent years, most notably in Latin America, but no developed nation has defaulted on bond obligations in modern times.

Latin American nations allowed their currencies to plunge in value against the dollar in order to export their way back to recovery. But Greece adopted the euro and lacks this option. It's being asked to take severe austerity measures like those imposed in Latin America, without the escape valve of currency devaluation.

A Greek default on its debts likely won't be allowed until EU leaders have built a financial firewall around their banks to ensure that Greek default doesn't lead to a contagion of financial panic in other countries.

"On one hand, you have to say that creditors have to take a hit ... but when exactly do you want creditors to take a hit, and how you manage contagion? It is uncharted territory," said Nicolas Veron, a senior economist at Bruegel, a Belgium-based economic think tank.

There's another complex wrinkle.

European leaders are trying to boost a bailout fund by issuing new debt to replace old debt that's at risk of default. But by taking on additional debt, these nations, particularly France, risk a downgrade by credit-rating agencies because of their swelling debt loads. That would raise their borrowing costs, making it harder to deal with the mounting debt crisis.

One major source of strife between European leaders is how large their European Financial Stabilization Facility, the so-called bailout fund, should be. The EFSF began issuing bonds in January to essentially backstop borrowing by struggling member countries.

As market turmoil grew, this fund was expanded in March, and again in July. It now stands at 780 billion euros ($1.074 trillion), with loaning funds of 440 billion euros (about $606 billion.).

The White House put out a statement late Thursday saying President Barack Obama discussed the European crisis via videoconference with German Chancellor Angela Merkel, French President Nicolas Sarkozy and British Prime Minister David Cameron, (whose country retains its own currency, the pound sterling, not the euro).

"Chancellor Merkel and President Sarkozy fully understand the urgency of the issues in the Eurozone and are working diligently to develop a comprehensive solution that addresses the challenge and which will be politically sustainable," the White House said in a statement that was as much nudge as support.

Some analysts warn that if EU leaders cannot make credible progress soon, it could ultimately lead to collapse of their 60-year experiment in integrating Europe. French leader Sarkozy sounded that theme recently, warning that failure could return Europe to its dark past, which led to two world wars in the first half of the 20th Century.

In Senate testimony Thursday, prominent economist Fred Bergsten dismissed that possibility, contending that Europeans have worked too long and hard to let that happen.

"The Europeans are not going to let the euro collapse," said Bergsten, who heads the Peterson Institute for International Economics in Washington. "We'd better understand and support their moves to fiscal union, because that is the positive outcome for them and us over time."